Exit music for a streaming service

On Monday Warner Music Group held its quarterly conference call with analysts. Among the usual discussion of forward-looking statements, and everyone's favourite non-GAAP metrics, was the question of whether Warner had cashed out its Spotify equity stake.

Turns out we got clarification -- on the call, chief executive officer Steve Cooper revealed:

Subsequent to the quarter-end we sold about 75 per cent of our Spotify equity for approximately $400m.

We received confirmation on page 22 of the 10-Q that Warner filed that evening. Of note is that Warner aims to distribute the proceeds equitably among its artists, rather than retaining the proceeds for shareholders.

In a similar vein, last week Sony revealed it had now sold half its equity in the artist extraction platform, reducing its stake to from 5.7 per cent to 2.9 per cent, realising a ¥50bn cash gain, or around $455m, in the process.

Our readers may recall that we have previously theorised about how Spotify's public listing could change the existing dynamic between the labels and the streaming service. The labels, who hold the keys to Spotify's long-term profitability with regards to the royalty payments they charge, may be less inclined to give Spotify better terms if they are no longer shareholders. After all, why give away profits when you control the content that Spotify depends on?

Mr Cooper sort of addressed this particular issue on the call:

Just so there won't be any misinterpretation about the rationale for our decision to sell, let me be clear -- we're a music company and not, by nature, long-term holders of publicly traded equity. This sale has nothing to do with our view of Spotify's future...we're hugely optimistic about the growth of subscription streaming.

It's plausible, however, that Spotify can be both a growing revenue source for labels and a middling business for investors. If it manages to grow revenues faster than its operating costs, Spotify will still eventually eek out a profit, albeit not at the levels it projected before its direct listing.

Of course, Spotify has plenty of other potential profitability levers outside of its royalty rate, such as its rapid expansion into podcasts or its tie-in with Hulu, but few will move the needle like lower content payments.

Spotify may also argue, as chief executive Daniel Ek suggested on the quarterly earnings call, that the data it provides to labels, for instance about user demographics, will help to keep it on favourable terms with its suppliers in the future.

Having targeted 30-35 per cent gross margins in the long term, as opposed to the 25 per cent it achieved last quarter, the acid test will be when Spotify sits down with the labels to negotiate new terms in 2019. The Swedes may be hoping in the future that their content partners still think about their mutually beneficial relationship as long-term stakeholders, regardless of their slowly diminishing shareholdings.

Further Reading:
Canvassing Spotify's valuation
- FT Alphaville
Sony fast out the door at Spotify listing
- FT Alphaville

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